Bed Bath & Beyond Inc. (BBBY) CEO Mark Tritton on Q3 2021 Results - Earnings Call Transcript

The Weir Group PLC (OTCPK:WEIGF) 2022 Interim Results Earnings Conference Call July 28, 2022 3:00 AM ET

Company Participants

John Heasley – Chief Financial Officer

Jonathan Stanton – Chief Executive Officer

Conference Call Participants

Will Turner – Goldman Sachs

Mark Davies Jones – Stifel

Klas Bergelind – Citi

Vlad Sergievskii – Bank of America

Jonathan Stanton

Good morning, everyone and welcome to Weir’s Interim Results Presentation. I’m joined today by our CFO, John Heasley and we’ll follow our usual format. So after some opening remarks from me, I’ll hand over to John to take you through the financial review in detail. And then I’ll return with the business review, including an update on our strategic progress and the outlook for the group and our markets. We’ll then open up for questions.

Now before I start, I’d like to mention the management changes we also announced today. After 43 years of service, Ricardo Garib will retire as President of the Minerals division at the end of 2022. He’s made an enormous contribution to Minerals and Weir. And since his appointment as President of Minerals in 2016, he has led the division from strength to strength. Ricardo will be succeeded by Andrew Nielson, who is currently President of our ESCO division.

Since assuming that role in early 2020, Andrew has delivered the acquisition synergies, built the growth strategy and transformed safety and operational performance. We are well advanced with our process to identify Andrew’s successor and expect to announce further details in due course. I’d like to pay tribute to Ricardo for his outstanding contribution over many years and take the opportunity to wish him the very best in his retirement. I’m delighted that Andrew will succeed Ricardo. He knows the Minerals division extremely well and has a wealth of experience from across our business. I know he’ll continue Ricardo’s great work, taking Minerals to new heights. And I look forward to working with him in his new role.

2022 marks our first full year as a focused mining technology company. Our mission is to make mining smarter, more efficient and sustainable. And the benefits of this focus and our potential for growth and margin expansion are becoming ever clearer. In the first half of the year, market conditions have been extremely favorable, particularly within mining. And we’ve successfully navigated through a complex operating environment. We saw excellent demand for our sustainable solutions and spare parts which culminated in us delivering record aftermarket orders. Operationally, we executed strongly, as reflected in year-on-year growth in revenue and operating profit, with inflationary pressures mitigated. And we exit the first half with considerable momentum in manufacturing and supply chain. As a result, we remain on track to deliver our expected full year margin expansion and make meaningful progress towards our 2023 operating margin target of 17%.

We have also set more ambitious emission reduction targets and submitted those to SBTi for validation, strengthening our sustainability commitments. And today, we’re announcing a new program to transform business processes across the group, driving lean philosophy across our end-to-end value chains and maximizing the use of global business services. And driving a leaner and more efficient Weir will deliver £30 million of annual savings and operating margin expansion above 17% beyond 2023.

Our first half performance reflects the strength of our business and the passion of our people. And I’d like to thank my colleagues across the globe for their hard work and commitment to strong execution and delivery for our customers.

The newly focused Weir now has the potential to deliver compounding growth and margin expansion as we drive to deliver the value from our portfolio transformation over the past few years. We believe that there is a multi-decade growth opportunity ahead of us, underpinned by the global imperative for decarbonization where: one, the world needs to mine more metals if it’s going to reach net 0; two, the mining industry needs to extract these metals in a more sustainable way; and three, ore bodies are harnessed and ore grades are declining. This combination of factors creates a compelling opportunity for Weir with our track record of innovative engineering.

In addition to the fundamentals of the market, we have levers which will accelerate our growth ahead of the market. The first lever is our technology drivers where we have the best brands and engineers in our space. Our technology-led strategy means we are supporting our customers with their biggest challenges and playing a critical role in leading the technology transition within mining. The second lever is our strategic growth initiatives, such as the mining capital expansion strategy in ESCO and our HPGR and comminution business in Minerals. These and our other initiatives will see us expand our addressable markets and gain share across the book ends of our business today.

And with our new transformation program, we’re adding a third lever to our growth and margin targets. With some of the recent challenges behind us, we now have a real opportunity to drive synergy across our business processes that was not available to us before. This program will see us take advantage of those opportunities and I’ll share more details on this later in the presentation.

So, I’m very pleased about what we’ve delivered and I’m feeling really good about the future. We’ve had a great first half. Our markets are positive. We’ve got great momentum. And we’re on an accelerated growth trajectory for many years to come.

With that, I’ll hand you over to John to take you through the numbers. John?

John Heasley

Thank you, Jon and good morning, everyone. I’m delighted with the first half results which show 14% growth in orders, 18% growth in revenue and a 15% increase in operating profit. Demand for aftermarket was particularly strong, with orders up 23%, while OE orders, excluding the 2 large one-offs last year, were up 18%. Revenues accelerated in Q2, as we saw the impact of COVID and supply chain challenges start to ease. And with book-to-bill at 1.17, we carry a strong order book into the second half of the year.

Operating profit of £168 million was 15% higher than last year, while operating margins reduced, as we expected, by 40 basis points to 15.3%. We again showed the benefit of being the market leader across our key products, maintaining gross margins by increasing sales prices as required. Profit before tax of £143 million was £24 million ahead of last year, including an FX translation tailwind of £3 million, with EPS at 40.5p per share and an interim dividend of 13.5p per share.

Free operating cash conversion was impacted by an increase in working capital, with an inventory build supporting our strong order book. This, plus the recent acquisitions of Motion Metrics and CIS, resulted in net debt to EBITDA of 2x. As I will come on to explain, we continue to expect full year cash conversion of 80% to 90%.

I’ll now turn to provide some detailed commentary on each of the divisions. Starting with Minerals, conditions in mining markets continued to be favorable, as commodity prices across our main exposures of copper, gold and iron ore continued to motivate our customers to maximize production and in some cases, also mining lower grade parts of the mine. While larger OE projects remained slow to convert, customers were very active in upgrade and debottlenecking solutions to drive more production from existing assets.

Activity in the Canadian oil sands was also strong, supported by the oil price. These conditions resulted in aftermarket orders being up 21%, including the benefit of price increases which we estimate at somewhere between 4% and 6%. OE orders were up 17%, excluding the prior year one-offs, driven by small upgrade and debottlenecking solutions, where customers were looking to secure quick increases in production volumes to benefit from the strong commodity price environment. With our highly qualified sales and application engineers located close to mine sites, this is a real sweet spot for us. A great example of this is a notable increase in upgrade orders for our largest slurry pumps which, of course, will also drive a long-term attractive aftermarket revenue stream.

Revenues were 16% higher than the prior year, with aftermarket up 17% and OE up 13%. Revenue accelerated through the period, as the impact of COVID and supply chain challenges started to ease, with Q2 revenue 22% higher on a sequential basis. Product mix was broadly in line with the prior year, with OE representing 25% of revenue compared to 26% last year.

Operating profit increased by 11% to £135 million, as the division benefited from increased volumes and strong execution, while margins reduced by 70 basis points to 17.3%. Gross margins remained rock solid as we continued to successfully pass inflationary cost increases on to customers. The benefits of operating leverage and continued operational efficiencies were offset by a return of T&E costs post-COVID and non-repeat of prior year one-offs, increased R&D spend and adverse transactional foreign exchange phasing. This was all as anticipated. And we continue to expect to see good progress towards our medium-term margin targets on a full year basis.

Moving on to ESCO, where we experienced similar mining market conditions as the Minerals division, with infrastructure markets also continuing at strong levels, especially in North America. Total orders increased 27% to record levels, including a 7% benefit from the acquisitions of Motion Metrics and CIS which are both trading ahead of our expectations.

Light [ph] Minerals growth included a mid-single-digit percentage benefit from pricing. As well as gaining share in our core GET space with positive net digger [ph] conversions in the period, we’ve been particularly pleased with our capital strategy, where we sold more than 50 large buckets in the first half, from a standing start just 18 months ago, as the efficiency benefits of our engineering and digital capability is increasingly recognized by customers.

While we saw a sequential reduction in orders in Q2, this was reflective of some specific temporary mine closures and the mechanics of running down the inventory related to our acquisition of CIS, our distributor in Canada. Underlying market conditions remain buoyant.

Revenues increased by 24% to £314 million. And like Minerals, we were pleased with the execution which again accelerated into Q2. This was especially impressive for ESCO given that one of our key foundries based in Xuzhou in China was forced to close for a few weeks in April as COVID lockdowns hit. The team had done a great job to catch up production in the second quarter.

Operating profit at £51 million was 21% higher than last year as the division benefited from increased volumes, while margins were down 40 basis points at 16.1%. Like Minerals, the benefit of operating leverage was offset by the return of T&E cost post-COVID and increased R&D spend. But as you will also remember, H1 margins last year benefited from favorable phasing of price increases relative to raw material purchase contract renewals.

Now bringing things together to look at group operating margins. Overall group margins have reduced 40 basis points in the period to 15.3%, driven by 4 main factors. Firstly, with high currency volatility, we’ve seen greater than usual swings in valuation of derivatives used to hedge operational purchases and sales in nonfunctional currencies. This amounted to around £2 million or 20 basis points and represents a timing difference, with the corresponding upside coming when the underlying hedge transactions take place in future periods.

Secondly, we’ve seen good operating leverage, benefiting margins by 70 basis points, including the impact of exceptionally high freight costs in the period. This net efficiency benefit from higher volume was partly offset by 40 basis points incremental investment in R&D.

Thirdly, the slightly favorable aftermarket mix in Minerals revenues provided a 30-basis points benefit. And finally, the return of travel spend in H1 to close to pre-COVID levels had a 50 basis points negative impact.

And as mentioned last year, 2021 included a number of one-off gains, such as the sale of a property which amounted to a 30-basis point headwinds this year. This all left margins where we expected at 15.3%. And we remain on track to show good progress over the balance of the year towards our 17% medium-term target. As a reminder, the second half margins will benefit from further operating leverage as volumes increase, further cost efficiencies, the non-repeat of the prior year cyber impact and of course, as always, maintaining our gross margins against the pressures of inflation. The margin progression that we saw from Q1 to Q2 as volumes increased and supply chain pressures eased underpins our confidence.

Turning to cash flow. We saw a working capital outflow of £112 million which is reflective of a buildup of inventories in both Minerals and ESCO to support our increasing order book. Inventory has also been impacted by some supply chain disruption, especially for Minerals OE projects where we are dependent on third-party suppliers for components such as motors or bearings. As those components which may have a relatively low value have in some cases been delayed, the whole project inventory, including the high-value product we have produced, remains with us until the whole project is complete. Additionally, freight delays have meant that there is a higher volume of inventory in transit than would ordinarily be the case.

As we move through the half, we saw these factors start to ease which helped our revenue momentum with a 20% sequential increase in Q2. However, as a consequence, revenues were back-end loaded. And therefore, as at the year-end, a higher level of debtors remained than would be the case with a more level-loaded revenue profile. This is simply a phasing issue with no concerns on aging or recoverability. As a result of the above, free operating cash conversion was 29%. Given revenue and supply chain momentum, we continue to expect much of this working capital increase to unwind and underpin cash conversion within our target range of 80% to 90% on a full year basis.

Turning to the next slide. Free cash outflow of £24 million compared to an inflow of £45 million last year, mainly due to the operating cash flow just described. With regards to net debt, we saw absolute levels increased by £188 million after acquisitions and dividends. This includes an adverse foreign exchange retranslation of £92 million which, of course, represents a partial balance sheet hedge of our U.S. dollar net assets, with the overall net asset translation benefit being positive in the period. This leaves net debt to EBITDA at 2x on a lender covenant basis. And following the refinancing of our RCF during the period, we continue to have significant long-term committed liquidity.

Briefly, this slide sets out some financial guidance for this year with a few points to highlight as follows. Firstly, with the strengthening of the U.S. dollar, based on June rates, we would see a £10 million full year operating profit translation tailwind, of which £4 million was seen in H1. Secondly, as just explained, we continue to expect free operating cash conversion of 80% to 90%. And thirdly, as previously discussed, our Russia net assets which mainly comprise working capital, represent around 2% of the group total. And therefore, depending on our progress in winding down our order book over the coming months, we could face a worst-case exceptional asset write-down of up to £30 million over the balance of the year. In addition, we will start to incur exceptional costs related to our process transformation program which we expect to be around £10 million this year as part of the overall cost of up to £45 million over the next 3 years.

In summary, our markets and our business are in great shape. We’ve seen record levels of aftermarket demand in the period and delivered strong revenue and profit growth, with our margin trajectory as expected. While cash conversion was impacted by higher-than-normal level of working capital, revenue momentum means we continue to expect to see elevated inventory levels unwind over the second half and cash conversion to increase accordingly.

We enter H2 with good momentum and remain confident in our medium-term growth, margin and cash conversion targets, with further margin upside beyond 2023 now underpinned by our new process transformation program which will deliver £30 million of annualized savings by 2025.

Thank you. And I will now hand back to Jon.

Jonathan Stanton

Thank you, John. In this next section, I’ll expand on the progress we’re making towards our strategy and medium-term goals.

First, let me remind you of the strong high-quality mining technology business we have today. Weir has a unique position across the mining value chain, with leading market positions and premium brands. We’re operating every day at the very heart of mining processes. Our highly engineered technology, increasingly, with added digital connectivity, is mission-critical to our customers who rely on our solutions to avoid downtime, downtime that can cost them up to $10 million a day on a large mine. We’re very focused in where we operate, concentrating on high abrasion applications which generate strong aftermarket demand. And we support that demand through our extensive service network. Having sold the original equipment, we have the opportunity to provide spares and service in the aftermarket. For every original equipment sale, we sell on average around 30% of the original value in spare parts every year. And that figure is even higher for our large Warman slurry pumps which gives us a reliable annuity-like revenue stream throughout the mining cycle.

As I touched on in my introduction, our deliberate repositioning to focus on mining technology is enabling us to take advantage of the multi-decade growth opportunities that exist in partnership with the industry we serve. It’s clear that the world needs to extract more metal to satisfy a growing population and more importantly, to enable the clean energy transition. This is translating into significant increases in demand for metals like copper, nickel and lithium. At the same time, our mining customers need to get more from less. The decline in ore grades means more material needs to be processed, using less energy, using water wisely and creating less waste. Without a reduced environmental footprint, our customers will not have the social license to operate.

And therein lies the challenge, more essential resources are needed for electrification and renewable power generation to get to net 0. And the way those resources are produced must significantly change. So mining needs to become smarter, more efficient and sustainable. And this presents Weir with tremendous opportunities that play right to the core of our purpose.

Our strategic ambitions are very clear and focused on the areas that will deliver against those opportunities which are aligned to our Weir [indiscernible] framework and its 4 pillars of people, customers, technology and performance.

First and foremost, our unwavering goal is to be a Zero Harm workplace and one where people can be themselves, feel like they belong and do the best work of their lives. We’re aiming to grow ahead of our markets by getting closer to our customers, working in partnership to solve their biggest challenges and playing our part in the mining industry’s transformation to Net 0.

On technology, we continue to invest to expand our development pipeline, combining engineering excellence with digital capability to create sustainable and novel solutions. And as we grow profitably, we will be leaner, cleaner and more efficient, supporting expanded margins and strong cash conversion, demonstrating the quality inherent in our business. Our new business transformation program will underpin and enhance that performance.

We’re making good progress across each of these pillars which I’ll now expand on over the next few slides. Turning first to people. Safety is always our #1 priority. And I’m pleased that our total incident rate in the first half improved. At a rate of 0.33, we remain world-class in our sector. Our goal continues to be absolute Zero Harm and we’re now launching a new Zero Harm behaviors framework across Weir to drive a further breakthrough in our performance.

In February, we ran our regular employee survey and participation levels remained excellent at 87%, with the Net Promoter Score unchanged, keeping us in the top quartile against industrial benchmarks. Having completed the deployment of the Workday HR system last year, we’re now leveraging that and have introduced a reverse mentoring program and started to roll out our new Weir-wide performance development process.

Inclusion, diversity and equity, or ID&E, is the cornerstone of our purpose-driven culture. We’ve seen some great activity in our affinity groups over the past 6 months. The most visible expressions of this came in June when we celebrated Pride Month and recognized the importance and contribution of our women in engineering roles. We continue to support our people and their families in Ukraine who, I am pleased to tell you, remain safe and well. In addition, our people around the world united in their generous support for our match funding appeal in aid of the wider humanitarian crisis.

Turning next to customers and technology and the strategic progress made by our Minerals division. As I’ve said, growing our installed base today gives us long-term aftermarket revenues in the future. And in the first half, we’ve seen really strong demand for our mill circuit solutions and particularly our large slurry pumps. For example, we secured a new order for a number of our largest Warman mill circuit pumps for a greenfield project in Argentina. Once operational, this will be the largest installed base of these pumps anywhere in the world. Each pump will generate around 100% of its original value in spare part sales every year.

Critical to supporting our installed base is continued investment in our service center network. And in the first half, we opened a new center in Kazakhstan. And we also committed to build a new facility at Port Hedland in Australia which will deliver the £15 million annual aftermarket contract for Iron Bridge due to start next year. Other commitments include a new center in the Tashkent region of Uzbekistan which will support the £14 million mill circuit OE order booked in the first half.

We also continue to see success with our integrated solutions, particularly as miners are running flat out and want to increase their throughput. That was the case at Capstone Pinto Valley copper mine in Arizona, where we’ve created an integrated solution to improve slurry flow through the mill circuit. Operating within the constraints of the existing footprint, our team redesigned the sumps and fitted Warman MCR feeder pumps. By looking at the process as a whole rather than individual components, the team increased the throughput and efficiency of the process.

On technology, we continue to enhance our digital offer. We’ve announced new partnerships with XMPro and AVEVA that enable us to extend the capability of our proprietary Synertrex platform. This will benefit customers, giving them data and insight to support real-time decision-making on the mine. We’ve also continued to invest in our portfolio for comminution, one of the most energy-intensive processes in the mine. We’ve upgraded and extended our range of small and medium-sized Enduron screens, making them more efficient and improving productivity relative to other solutions.

Moving on to ESCO, where we’ve secured some great orders across our core product range. In ground engaging tools, we continue to gain share with our market-leading Nemisys systems and delivered positive net conversions. We’re also winning share with our mining attachments as customers increasingly see the value of an engineered solution to improve dig efficiency while also reducing energy consumption. We’re leveraging this to promote our Motion Metrics offer which adds data-driven insights to our solutions. The first half saw us win an order for the first ever Motion Metrics ecosystem from one of the world’s largest gold miners and a key ESCO customer.

Our solution packaged a number of Motion Metrics proprietary products. The system provides GET tooth-loss [ph] detection, fragmentation measurement and bolder detection across the load haul and dump process. It gives the customer real-time data insights, allowing them to remove oversize material or foreign bodies from the ore before it reaches the crusher and disrupts the process. The solution will increase productivity and reduce cost, with an estimated investment payback for the customer of just one year. And this really demonstrates the potential we have to grow Motion Metrics as part of ESCO.

We were also pleased to acquire Carrier Industrial Supply, building on our long-standing distribution relationship. As well as delivering on ESCO’s strategy to have direct channels to markets in all major mining regions, the acquisition brings expertise in mining attachments and excellent underground capability which we can leverage across the ESCO network.

Turning next to performance and in particular, sustainability, where we have set more ambitious absolute emissions reduction targets to cut Scope 1 and 2 emissions by 30% and Scope 3 emissions by 15% by 2030. We’ve submitted these to SBTi for validation and we expect to hear back on that in the fourth quarter of this year.

So how are these new targets more ambitious? Well, firstly, we’ve switched from an intensity target to an absolute emissions reduction target which will drive deeper cuts in Scope 1 and 2. Secondly, in making our Scope 3 commitment, we are adding absolute targets for emissions in our downstream value chain for the very first time. And the Scope 3 target is especially exciting, as 97% of our emissions profile is due to emissions from our products in use over their lifetime by our customers. This is where we can make a big impact through technology, be it our technologies that optimize mining processes today or our transforming technologies that deliver step change improvements in environmental impact, such as our HPGRs.

Of course, these technologies need to go hand-in-hand with a shift to low carbon energy in mining. So it’s imperative that we partner with customers and others across the industry to drive the broader energy transition. I’m proud that our new targets will make a significant contribution to decarbonizing the mining industry. Putting this into context, delivering our new targets would mean that in 2030, we’d achieve an annual reduction of around 4.2 million tonnes of CO2 emissions. And that’s the same as the annual CO2 emissions of almost 1 million petrol cars today.

Staying with performance. I’m delighted to be unveiling our new business process transformation program. The 3 divisions we had in 2016 when I became CEO were very distinct from each other. They have different end market cycles, different customers and different manufacturing processes. And as a result, there were a few opportunities for optimization. We’ve now reached an inflection point where we can drive more value from the business we have today given our enhanced strategic focus and compelling opportunity for growth. As I described earlier, this provides an additional lever to accelerate our growth through optimizing the structure of our operations and driving synergy across our processes.

Our new program will achieve that, focusing on 3 main areas: firstly, driving lean philosophy across our end-to-end value chains; secondly, maximizing the use of global business services; and third, leveraging the recent investments we’ve made in foundational systems, such as Workday and SAP. The program will give us a scalable and efficient platform that will underpin our future growth. We expect the annual cost savings delivered by the program to be £30 million and these will be realized over the next 3 calendar years. The early benefits will underpin our 2023 operating margin target of 17% and will support operating margin expansion beyond 17% in subsequent years.

So putting everything together, I want to reaffirm our confidence in delivering the following medium-term goals: first, growing revenues ahead of our markets through the technology-led strategy and our business growth initiatives; second, expanding group operating margins to 17% in 2023 through operational leverage, the elimination of recent one-off effects and underpinned by the initial benefits of the transformation program. And that program will also support margin expansion above 17% beyond 2023. Third, achieving 90% to 100% operating cash conversion in 2024 and beyond. And finally, continuing to fulfill our sustainability commitments, including the more ambitious emissions targets announced last week. And we’ll deliver this while continuing to invest in our people and technology to support our strategic ambitions.

Before I turn to the outlook, in the context of the current macro environment, I did want to take a minute to reiterate the foundational strength and resilience of our business.

Our Minerals aftermarket which is what generates the vast majority of the division’s profit and cash and which has the highest aftermarket contribution of all its peers, has grown through multiple cycles in the last 12 years. In that period, we’ve seen the end of the mining super cycle, the shift from volume to value is minus CapEx, a return to growth as the global economy strengthened and new supply was commissioned and of course, the recent the impact from the COVID pandemic. Throughout these 12 years, the business has been highly resilient, growing through each cycle, delivering a CAGR of 7%. Part of that growth has come from an expanding installed base. As even in a lower CapEx environment, customers want our integrated and sustainable solutions to help improve efficiency and increase production from existing assets. This is what underpins the margin resilience of the Minerals business. And since acquisition, ESCO has demonstrated exactly the same characteristics.

So finally, let me comment on what we’re seeing in the market and the outlook for the balance of the year. Current market conditions are positive. And we continue to see high activity levels in mining. Commodity prices are well above incentive levels. And for the vast majority of the world’s copper, gold and iron ore mines, they are also well above miners’ cost to produce. And this is illustrated in the graph on the right-hand side of the slide. These conditions support strong demand for our mining spare parts and expendables and our debottlenecking and brownfield solutions as customers seek to maximize production from existing assets. Our pipeline of large projects continues to grow, supported by long-term demand for future-facing commodities, albeit, as you know, timing of conversion can be lumpy.

So on to the second half of the year, we’ve had a good July as the order momentum we saw build through the first half has continued and we remain successful in navigating complexities in the operating environment. We go into the second half of the year with a fantastic order book and great momentum. So in the round, we continue to expect to deliver strong constant currency revenue and profit growth, with operating profit towards the upper end of the range of analysts’ expectations. We also expect to show good progress towards our medium-term margin and cash targets.

Before we move to questions, let me quickly summarize the key messages from this presentation. Weir is a premium, highly resilient mining technology business. Through innovative engineering, we have a compelling opportunity to make mining smarter, more efficient and sustainable. Long-term trends from technology-led transition to net zero mining are in our favor. And we have a clear strategy to deliver profitable growth ahead of our markets while delivering sustainable margin improvement. That’s why I’m excited about the prospects of our business for the rest of this year and beyond.

Thank you. John and I will now be pleased to take any questions that you have.

Question-and-Answer Session

Operator

[Operator Instructions] The first question today comes from the line of Will Turner from Goldman Sachs.

Will Turner

The first one is on your guidance. So obviously, you had a strong first half relative to where market expectations are and your guidance is also implying quite significant upgrades to the second half market consensus. I was just wondering, how are you thinking about the kind of weakening macro data which many common indicators have been highlighting in recent months. And in particular, in your guidance, are you factoring in any potential slowdown for ESCO which is obviously the more cyclical and the more non-mining exposed of your businesses?

Jonathan Stanton

Yes. Will, thank you for the question. So yes, we’re obviously very conscious of the macro environment, the inflationary environment and the fears around recession. But I’d repeat what was in the statement as far as we see very high levels of activity across our mining markets. Through July, the momentum has continued. We’re not seeing any signs of slowdown. Commodity prices are significantly above production costs and indeed, long-term incentive levels, particularly for the commodities that we’re exposed to. And the miners are generalizing but very, very active at the moment in terms of continuing to increase production against some challenges that they have, particularly as commodity prices have softened a little bit. So production is the lever that they have. And that’s translating into — with the equipment being running harder. It’s translating into lower grades being mined now relative to maybe what was mined during the COVID period. And the general grade decline continues.

And on top of that, we’re seeing the benefits of some of our installed base coming through. So lots of favorable things in the mining world. And we don’t see any change to that given where commodity prices are today and the activity levels that our customers are talking about. So we feel good about the balance of the year from a mining perspective. And as we flagged in the statement, the one area of softness and we’ve seen this already, is in infrastructure in Europe. But that is clearly a relatively small part of our business. And we’ve already seen the effects of that in ESCO through the first half of the year. So in effect, that is already net in our numbers and we don’t see that improving. But across the rest of the portfolio, we feel very good about the activity levels at the moment.

Will Turner

Okay. But you’re not seeing any slowdown in the U.S., although…

Jonathan Stanton

No.

Will Turner

There could be a potential slowdown towards the end of the year. Another question I had on — was on inventory. It’s obviously a bit of a headwind. What gives you — you’re clear in the sense that you expect this to reverse at least partially in the second half. But what gives you confidence that the inventories will reverse and you’ll be able to deliver what the progress in the build of that?

John Heasley

Thanks, Will. I’ll take that part of your question. So as you saw, we had an inventory build circa £100 million in the first half of the year. Obviously, part of that was order book related with the strength in orders. That’s inventory that we just need to carry to allow us to deliver on our obligations over the second half of the year. However, there were another couple of key drivers in there. One, supply chain disruption. So especially in respect of our Minerals OE projects where we have to buy some components like bearings or motors and to support those projects. They may be relatively low value items. But if they are delayed coming in, then all of the inventory related to that project sticks with us. And that includes the high value, whether that’s HPGRs or pumps or screens that we’ve produced ourselves. So that’s one driver of the higher inventory.

The other one being freight. So freight logistics, especially coming out of China, remain complex, especially through Q1. And so as we think about that £100 million build, I would say roughly half of that relates to those 2 specific items in respect of supply chain and freight. And as you can imagine, we’ve been through in great detail the projects that those relate to. We can see visibility on how freight lines are easing up. And therefore, we’ve got really high confidence in that half of the inventory build unwinding over the second half of the year.

On the bit related to the order book, obviously, we will continue to drive efficiencies in our inventory as best we can. But to some extent, that will be — what it will be. However, in the round, we’re confident in the majority of that first half build unwinding over the second half of the year. And that will support the free operating cash conversion in our target range of 80% to 90% and of course, support leverage moving down towards the top of our 0.5 to 1.5 range.

Will Turner

Great. That’s very fair. And thanks for further color on the leverage. And my final question is, how is Motion Metrics performing? Obviously, it’s a relatively expensive acquisition. But are you already seeing any meaningful synergies? And did it have a role in the kind of better-than-expected performance of ESCO in the most recent quarter?

Jonathan Stanton

Yes. So absolutely delighted with how Motion Metrics has been integrated into the Weir family and how it’s performing. Obviously, it was our first sort of technology acquisition. So we were very mindful of that as we went through integration and making sure we manage through the cultural aspects of that integration. But I’m delighted with how that’s gone. And the team is happy as part of the Weir family which is great to see. I think in terms of how it’s performed in the first half, slightly ahead of expectations which is great. We’ve had tremendous interest and pull from our customer base for the core offering. And as I mentioned in the speech, we’re already starting to sort of pilot the broader opportunity with Motion Metrics across all of the mine working in conjunction with both ESCO and the Minerals division. So very, very happy with how it’s going. The pipeline is building very strongly. I’m very excited about the potential for us to bring data and insights through the Motion Metrics artificial intelligence across our broader value proposition for our customers.

Operator

The next question today comes from the line of Mark Davies Jones from Stifel.

Mark Davies Jones

If I can go back to the first question that Will asked really about the outlook. Clearly, the bullish picture you’re giving is somewhat a contrast with fears of recession as relatively downbeat commentary from some of the big miners recently and commodity prices coming back a bit. I absolutely understand the resilience of the aftermarket side of your business and the vast majority of it. But on the OE piece, do you think that might slow down for you after a stronger period? And to go back to your picture of the longer-term outlook. I see the demand for these core minerals for the energy transition but is the willingness to make those greenfield investments there. You talk about social license but there’s also sort of shareholder license behind that. But there seems to be still reluctance to make those commitments to deliver that increased growth. Is that a concern?

Jonathan Stanton

On the one hand, it is, yes. From a personal perspective, it’s quite perplexing. And I think, as I’ve been saying for a while, the elephant in the net 0 room is that if we want all of these electric vehicles and heat pumps and everything else, then we need a hell of a lot more copper and nickel and lithium and all of these metals, the future-facing enabling metals to do that. So the fact that the new supply is not coming on rapidly and decisions seem to be taking longer to work through the system, from a personal perspective, I find that quite perplexing.

From a Weir point of view, of course, we’re somewhat agnostic. Because if we do see a surge in CapEx and new brownfield and greenfield expansions come through, then that’s fantastic. We’ll take advantage of that. That will allow us to have a significant step-up in our installed base. But if it remains sort of in the current sort of stuck-in-the-mud sort of situation that we’re in just now, then, of course, what that means is that our customers will intensify their efforts to increase production from existing mines and do more of the debottlenecking, more of the brownfield, smaller expansions which has characterized our OE over the last year or 2. And of course, as you know, it’s really our sweet spot, I mean given our footprint, our boots on the ground in the mines and our ability to work closely with customers to understand and unlock some of the production and productivity issues that they have on existing mines.

So I think from a Weir perspective, we sort of win either way. I mean I prefer more expansion to be coming through because that’s what we need for the health of the planet. But it is a bit locked up at the moment, I will admit.

Mark Davies Jones

Okay. And then on the business process transformation program, just to clarify, £30 million of savings. Did you say the cost of that is £45 million? Pretty substantial investments. Is that around investing in technology? Or is there some restructuring and headcount to come out of that process?

Jonathan Stanton

Yes. So I mean, stepping back, I think as we’ve worked through the challenges of the last 12 months with COVID, our cyber-attack, the logistics challenges in recent times, it feels like those things are now in the rearview mirror or heading in that direction for us. And we have much — a very, very clear line of sight in relation to our 17% margin target for 2023. So we felt it was the right time now thinking about the value creation opportunity beyond that to actually be quite forthright in terms of how we’re going to get there. We’ve talked about in the round some of the things in the past around leveraging systems and shared services. But we think there is a broader opportunity to not only do those things on a more accelerated timetable in terms of driving towards global business services, for example, across our functions, leveraging the investments that we’ve made in IT but there’s also a broader operational opportunity as well.

And a couple of highlights of that. For example, we need to continue — our regions grow at different rates. We need to continue to optimize the service center footprint, for example. In ESCO, 3 of our 5 foundries are now really humming and at the kind of pace and cost per tonne that we were looking for. We still got work to do in a couple of the other foundries. And then in Minerals, I think we’ve done and the team has done a great job on the integrated solutions strategy to drive growth. But I think as I look at the fulfillment behind that strategy, then we’ve created some complexity. And there is now an opportunity to really think about how we lean out the global value streams, value chains that will enable that and allow us to become leaner and more efficient. And of course, against the backdrop of the recessionary environment that you talk about or the macro concerns, then it’s no weakness to say we’re going to have a look at ourselves and make sure that we’re lean and trim across the cost base and ready to face whatever lies ahead.

Mark Davies Jones

Excellent. And can you give us an indication of the phasing of the cost of the program?

Jonathan Stanton

Yes. We expect to see — yes, of the £45 million, we expect to see some to come through towards the back end of this year and then sort of balanced over the remaining 3 years as we seek to deliver the upside opportunity in the margins. And I should say that the fact that we will incur those costs does not mean that we are backing away from our cash conversion targets over the next 3 years. We expect to take those — take the cash cost of the work that we will do and still deliver on the cash conversion targets that we’ve set out.

Operator

The next question today comes from the line of Klas Bergelind from Citi.

Klas Bergelind

Klas at Citi. I just want to come back to the cash conversion target which now looks even more back-end loaded than I thought. I mean half of this, you say, seems to be linked to bottlenecks, with shipments held back because of components missing and so forth. Did you say that you have seen bottlenecks easing, because that’s a quite big assumption that quickly can change? I mean, some people would say, that the China lockdown impact might still filter through to global supply chains. And also, on operating profit, the up to £20 million impact from Russia, this could also weigh on the conversion here. Can you just confirm that you haven’t seen much of the £20 million yet?

John Heasley

Yes. Thanks, Klas. The — in terms of the cash conversion and supply chains, yes, I mean we are seeing things — or we did see things easing through the back end of the second quarter and continuing into the start of the third. Of course, things aren’t perfect. But we’ve adjusted our lead times in terms of when we’re ordering. We’re adjusting how we’re procuring freight, et cetera, et cetera. So while the environment is by no means perfect, what we have had is a period of time to slightly adjust how we operate and how we adjust our lead times for ordering, et cetera. And that’s starting to now flow through in terms of how predictable and reliable components are coming into us. So yes, I just — I would just reaffirm my response to Will’s question which is we’ve done a lot of work in analyzing out the status of those components, where they are in the supply chain, whether they’re on the water, whether they’re still with suppliers. And we’ve got high confidence that, that — around half of the inventory build has a clear path to unwinding over the second part of the year.

In terms of the £20 million Russia impact, that’s something that we guided to earlier in the year in respect of sort of forward-looking. You remember last year, we had some pretty big orders coming in from Russia and therefore, the step-up that — we came into the year anticipating in terms of revenue and profits from Russia was quite significant and that’s what the £20 million represented. Clearly, that’s now been reflected in prior guidance. I think everyone is — in terms of the market is understanding of that. And therefore, I don’t think that there is any ongoing impact of that £20 million to factor in, in terms of H1, H2 bias. I think that’s all factored into things as we’ve presented today.

Klas Bergelind

Okay.

John Heasley

I’m sorry, Klas. The only just point I would add on Russia, while we’re talking about it, is in respect of the wind down of our business there which is ongoing. And of course, there’s a degree of complexity to that as we think about being responsible to all stakeholders, including our employees in Russia. And as I clarified earlier in the year, our net assets in Russia which principally represents working capital, is about 2% of the group total. As we wind down the business, there still remains the likelihood that there will be an exceptional write-down of some of that working capital in the second half of the year. And as I said in my speech, we see that as a worst case, the 2% of net assets which is up to £30 million. And of course, given its working capital, the majority of that would be noncash.

Klas Bergelind

Yes. No. I mean, obviously, Russia is a bit of a look-through element given that demand is strong elsewhere but I just wanted to clarify that second half likely impact. My final — my second and final one is on the order pipeline and in the context of the volatile commodities we see out there. We obviously feel well about the cost curves. It perhaps looks more ugly than hitting profitability at the miners at the moment. But just one question on bold [ph] CapEx. We have heard of a weaker outlook. Have you guys seen any difference between the different commodities anywhere? Or is it just even solid across copper, gold and so forth?

Jonathan Stanton

Yes. No, it is. I mean the reality is that in the current environment, we’re seeing strength across all of our regions. We’re seeing strength across our commodities. And if you look at the OE order input that we’ve had this year, we haven’t had many big projects. And we had a few new sort of large mill circuit pump installations, as I’ve talked about in my speech. But our OE is characterized by a lot of brownfield optimization, debottlenecking work. And the pipeline is full of a lot of that. It’s very, very active.

I’ll go back to my earlier comment. As commodity prices come down, then our customers, they’ve got is more production to protect profitability and that — they’re driving that really, really hard at the moment. That’s reflected in the OE order strength that we saw in the second quarter and it’s reflected in the OE pipeline that we have over the balance of the year. So yes, there is still a paucity of big OE projects in our pipeline but it is chock-full [ph] of smaller debottlenecking-type projects which, again, our sweet spot.

Operator

[Operator Instructions] Okay. Our next question today comes from Vlad Sergievskii from Bank of America.

Vlad Sergievskii

A few of them actually. First of all, very strong orders in the aftermarket and still very high book-to-bill as well. Presume that aftermarket orders are growing well above growth of the underlying installed base that you have, could you talk about sustainability of those growth rates and if you are seeing any support to orders from potential preordering from your client base which is still obviously very cash-rich [ph]? That’s the first one.

Jonathan Stanton

Yes. So I mean I can break down. If you think about our orders for the first half of the year, the constant currency increase was 23%. Within that, we saw, as we flagged in Q1, a small element of pre-buy. The effect for the first half is probably low-single digit, a couple of percentage points. We obviously have pricing, as we outlined. We saw strong price power and therefore, offset our inflationary cost inputs. That’s probably mid-single digit of those underlying orders. There’s a bidding for acquisitions with Motion Metrics and Carrier. The underlying volume growth in our aftermarket when you strip all that out is mid-teens percentage points which obviously is very, very robust. As I said earlier, that is driven by activity levels. It’s driven by all commodities remaining above incentive levels. It’s driven by our customers working very, very hard to increase production.

And even in a relatively flat production environment, having to process more rock to deliver the same amount of commodity, there was high-grading through COVID, generalizing not everywhere but high-grading through COVID which is now unwinding. We’re seeing the benefits of installed base growth and we’re seeing the continuing ongoing benefits of lower grades. So as we sit here today, we don’t see those things changing. And as long as commodity prices stay where they are, then it’s going to be a very, very buoyant and high level of activity kind of market for us.

Vlad Sergievskii

That’s great. If I also can ask about the revenue — cadence of revenue sequential growth between Q1 and Q2. I think you saw more than over 20% growth and it’s so more higher than any of other mining equipment companies actually delivered. Any specific reason for the strong sequential growth between Q1 and Q2?

Jonathan Stanton

Yes. I think the underlying growth was robust. In Minerals, as we’ve highlighted in the past, we do receive an annualized order in the second quarter which means that the second quarter is always the strongest quarter for Minerals. And if you look back over history, you can see always a sequential step-up from Q1 to Q2 in Minerals as a result of that annual order being booked in the aftermarket. In ESCO, you’ll see that there was a sequential step down in orders from Q1 to Q2. Underlying was robust. That’s really driven by the pre-buy that ESCO saw in the first quarter. It’s driven by the fact that a couple of ESCO’s customers were in shutdown through the second quarter, so we didn’t get the orders coming through there.

And then, as we acquired Carrier, we wound down the inventory in that business. So formally, they were a dealer and we didn’t — so we didn’t get orders from them. So those were the factors which drove the step down in ESCO which net-net is in the overall sequential growth. But I would reiterate what I said about what is driving the underlying activity in Mining across both businesses in the answer to your first question and that’s what we expect to continue to see over the balance of the year.

Vlad Sergievskii

Perfect. And my last one is related to net debt development. Was this increase in line with your original expectations or how those expectations changed as we progress through the sales cost? And then maybe a very housekeeping clarification. You mentioned 2x net debt to EBITDA leverage on lending covenant. When I do mechanically versus your 12-month reported trend in EBITDA, it looks more towards 2.5. Where the difference comes from? And your target leverage between 0.5 and 1.5, is it the target for lending covenant or is it the target of mechanical completion of leverage on the reported number?

John Heasley

Yes. I’ll take that, Vlad. So in terms of the — where we stood at the half year, then obviously, orders were a bit stronger. And as I’ve described, that fed to the increase in inventory to support the order book. So of course, inventory was a bit higher than we might have expected at the start of the year but for the reasons that I’m sure you know as well as [indiscernible] that’s commonplace and the macro backdrop is driving that. So yes, a little bit higher than we had anticipated. But as I’ve said, absolutely no change to our outlook for the full year in terms of cash conversion. That 80% to 90 is something that we retain as our outlook for the year. And as again, I’ve described in a couple of questions so far, we’ve got a very clear visibility to how we see that unfolding.

In terms of the leverage and the 0.5 to 1.5, that is on a lender covenant basis. That’s how we’ve consistently talked about leverage over a long number of years. And that’s on a trailing 12-months basis. Net debt, excluding leases — IFRS 16 leases to EBITDA. Again, that’s been consistent over a long number of years. And that is on an average exchange rate basis such that you don’t get the ratio being confused comparing average rates which is what our income statement has translated and therefore, results in EBITDA, to our balance sheet net debt number which is at a closing rate. So you need to look at them on a consistent currency basis which, again, is how it’s always been done. And in the range of 0.5 to 1.5, that’s where we said. We always said up to 2x for M&A. That’s why we’re sat at around 2x just now because we’ve just done the acquisitions of Motion Metrics and Carrier. And as I said, the cash conversion for this year will support us getting down towards the top end of the 0.5 to 1.5 range by year-end.

Operator

There are no additional questions waiting at this time. So I’d like to pass it back to the management team for closing remarks.

Jonathan Stanton

Well, thank you, everybody, for your participation in the call this morning. And for those questions, we very much appreciate that. Obviously, we’re available over the course of today through Ed [ph] and IR. If you have any follow-up questions, we’re very happy to deal with those. But thanks again for your participation and take care.

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